Little Did They Know: Responses to the Office of Financial Research’s Report on the Asset Management Industry

Thirty-five days ago the Treasury Department’s Office of Financial Research (“OFR”) fired a warning shot across the bow of the asset management industry. It delivered a report to the Financial Stability Oversight Council (“FSOC”) which, according to the Treasury Department press release announcing the report, “identifies industry activities that could pose risks to the financial stability of the United States.” OFR Director Richard Berner said “The report is an example of how the OFR serves the needs of the Council and collaborates with its member agencies.”

The SEC, one such “member agency,” might beg to differ. It took the unusual step of creating a webpage through which comments could be submitted in response to the OFR report. All Saints’ Day was the deadline for submitting comments and by the close of business, the SEC had posted 15 comment letters, a small number when compared to the thousands it has received in response to other opportunities to comment.

But while small in number the comments carry a substantial punch. Striking at the heart of the matter, commenters reminded the FSOC that its mandate is to guard against the moral hazard of “too big to fail.” But since asset management firms do not have a balance sheet requiring support, their failure cannot present the risk of a government bailout. As BlackRock notes in its comment letter, “Portfolio gains and losses accrue to investors, who may take their assets elsewhere with little market disruption if managers fail to perform. This may cause certain asset management firms to go out of business or be acquired over time, but this is not of systemic concern.”

And the academics agree. George Mason University’s Mercatus Center noted the report’s failure to distinguish between asset managers and the asset classes they manage. It also comments on the absurdity of trying to treat a $50 trillion industry as a cohesive whole in a thirty-page report.

Dechert LLP commented that FSOC reliance on the OFR report may actually backfire since it “will taint the administrative record” and provide “a basis for companies to challenge designation and other regulatory actions that attempt to rely on the Report.” Dechert identifies a number of the report’s fundamental legal and logical defects noting, for example, that investors purchase shares of a fund knowing that poor investment performance, including the loss of principal, is a natural and understood risk; that volatility and fluctuation of a fund’s net asset value are normal market features, not inappropriate risks that require extraordinary regulation and supervision; that the report treats a diverse industry in a one-size-fits-all manner; and that it fails to consider the role of existing SEC regulation.

The superficial approach the OFR took to analyze the industry was explored by Mayer Brown, which noted, “In the nearly 18 months it took OFR to produce its 30-page Report, OFR refused to make more than a show of consulting with asset management industry participants to learn the facts.” The law firm cites Reuters as reporting that although OFR shared a draft of its report with the SEC, it ignored the SEC’s feedback.